Thursday, November 14, 2013


When the question is whether or not a trust is up to date the answer can be complicated because so much of that depends on what has changed in your life recently.  However, a huge change in the law has left ticking time bombs in the hands of many unsuspecting people and I’ve decided that it is important enough to step outside of my usual format so you can be made aware of the problem:

But, since this is still an Ask Roxy post, first a little background:

FOR YEARS THE FEDERAL ESTATE TAX EXEMPTION HAS BEEN INCREASING DRAMATICALLY.  A federal estate tax exemption is the amount of money you are allowed to die with before the estate tax, sometimes referred to as the “Death Tax,” kicks in.

Just to give you an example of how completely crazy it has been look at what is has done in less than 20 years.

  • 1997: $600,000 
  • 2002: $ 1 MILLION
  • 2007: $2 MILLION
  • 2009 $3.5 MILLION
  • 2014: $5,340,000 ($10,680,000 for couples thanks to the new portability law. )

** It is also interesting to note that while the exemption has been going up the tax rate on the taxable portion of wealthy people’s estates has been going down.  For more check out this chart

As you can imagine, how much of a break to give the heirs of wealthy people is hotly contested.  That is a big chunk of what they were arguing over when you kept hearing people refer to the “Bush Tax Cuts” a while back.  Because it is such a hot political topic we couldn’t get a permeant law on the books for years.  The 2010 law had a “sunset”provision that meant everyone would have to renegotiate in 2012. Happily (at least for the wealthy), on January 1, 2013 President Obama signed into law a permanent exemption, indexed for inflation, that was almost 9 times more than the 1997 exemption (and, if you do have more than $10.68 million between you and your spouse you will be happy to learn that the tax rate tops out at 40%, significantly lower than the 55%-70% it was during the Regan era).

As you might imagine, all of the millions of people who voted for Obama were thrilled to find out that he upheld his promise of giving tax breaks to the rich.    

Just kidding, but the estate planning attorneys did have a much more clear cut job to perform after January of 2013 and that, my dear, is where you come in.  You, who had your estate plan drawn up prior to January 2013 (or even after), may now have a trust that will be unnecessarily expensive to administer after the first spouses death.  You see, all of the estate planning attorneys were really scrambling for a couple of years there because how could they promise their clients that the trust would do what it was meant to do when nobody knew what the estate tax exemption would be the following year?  For a little while it looked like all of those liberals were going to demand the exemption be reduced down to $1 Million.  That is big news in California where “land rich, pocket poor” often means people who have inherited over a million dollars worth of land, but have no other assets with which to pay the estate tax.  Oh no,  Lassie!  That mean ‘ol government is going to make us sell the family farm!

(also sometimes called a marital exemption trust, credit shelter trust, a bypass trust, or other similar name).  The A/B trust, described more fully below, allows the married client to avoid paying a significant portion of estate tax no matter what those crazy people in Washington decide to do with the exemption.  This way the lawyer can tell the client that she is doing everything she can to help the client avoid estate taxes.  But there is an added benefit to the lawyer, too, that she might not mention:


Many people are under the assumption that if they have a trust they will be able to avoid the many expenses of dying.  They are led to believe that because they avoided probate their heirs won’t have to dig too deeply into their inheritance in order to actually receive their inheritance.  In some sense this is correct: probate is an expensive hassle in California and administering a plain Revocable Living Trust is usually much less expensive.  However, trust administration of trusts that exist for long periods of time can end up costing more than the probate that you avoided.


While California has set a statutory limit of what lawyers are allowed to charged the bereaved in the probate setting there is no similar law limiting fees they can charge trustees to administer trusts.  The A/B trust is designed to keep certain assets in trust until both spouses die so, depending on the time difference between the deaths of the spouses, it could last a long while.

THE A/B TRUST STARTS OFF EXACTLY THE SAME AS EVERY OTHER TYPE OF REVOCABLE LIVING TRUST.  Many couples have no idea that they have an A/B trust because while they are both living the trust behaves exactly the same as any other type of revocable living trust.

In fact, you might be blissfully unaware that the discount trust you have has a dirty secret of expensive administration costs after the first spouse dies. 

THE BIG DIFFERENCE IS WHAT HAPPENS AFTER THE FIRST SPOUSE DIES.  The gist of an A/B trust is that after the first spouse dies the trustee divides the assets of the trust into two piles.  I’ll call them “Trust A” and “Trust B.”

  • Trust A: The assets that were moved into Trust A continue on as a trust that works for all intents and purposes in a very similar manner to the revocable trust that existed during the spouse’ life time complete with all of the original benefits (the main ones being: easy access to the property, income taxed at your personal tax rate, avoidance of probate at your death).
  • Trust B: Something very different happens to the assets of Trust B.  Those assets are moved into an irrevocable, non-grantor trust.  
Benefits of the B Trust:
  1. On the plus side the assets are excluded from the taxable estate of the remaining spouse because she never technically owns any of it.  So there is a tax break when she dies.  But, really, that is a worthless plus to most of us Californians because we don’t have a state estate tax and the federal estate tax laws allow the first 5.25 million of an individual’s estate (10.5 million for a couple) to pass on to heirs tax free.  
  2. The other plus of the B trust is that it allows the spouses to reach their cold, dead hand up from the grave and decide who will be the beneficiary of the trust.  In other words, because it is irrevocable, the person who is listed as the beneficiary in the original trust document cannot be changed.  You can see how this would be useful in a situation where you suspect your spouse might change the names of the beneficiaries after you die and give everything to her kids rather than yours.  

However, the drawbacks are several so listen up.

At the death of the first spouse:
    1) Your spouse’s hands are tied:  The B trust becomes irrevocable and non-amendable upon the first spouse’s death (the surviving spouse cannot alter those trusts, or add, change, or remove beneficiaries or gifts from those trusts). 
     2) Your spouse’s ability to access the funds are limited.  The surviving spouse’s use of the assets in the B trust must be limited to an ascertainable standard. 
     3) Your spouse must answer to the beneficiaries.  As the successor trustee, the surviving spouse is responsible and answerable to the future “inheritors” of the B trust for appropriately using the assets and must render accountings as well as provide a copy of the trust to the heirs and future beneficiaries. This puts the trustee (your spouse) in the awkward position of having to answer to the final beneficiary (probably your children).  There are lawsuits where children sue their own mother to preserve their future inheritance.
     4) Your spouse is in charge of doing all of the start up paperwork to get the B trust going.  The surviving spouse must properly allocate, title assets in, obtain tax ID numbers for, and maintain the B trust after the first spouse’s death.  That’s a lot of paperwork your lawyer will be happy to do for you. 
    5) Your spouse must do annual paperwork to maintain the B trust.  During the surviving spouse’s entire remaining lifetime they must continue to accurately track and keep records of the assets and transactions of each trust and complete separate tax filings for the A & B trusts each year.
    6) Your children could lose the step-up in basis that would have otherwise been automatic.  This is easiest to explain with an example.  Ma and Pa have one son Timmy.  Pa purchased stock in Acme, Inc. for $10.00.  When Pa died the stock was worth $100.00 but Ma did not have to pay the capital gains taxes on the $90.00 increase because there is a “step-up in basis” upon Pa’s death.  At Ma’s death the stock is worth $1000.00.  If the stock were in Ma’s name alone or in Ma’s revocable trust there would be another step up in basis and Timmy would not have to pay capital gains tax on the $910.00 increase in value.  However, if the stock is in the name of the B trust there is a step up in basis and Timmy does have to pay capital gains tax (or hire an attorney or a CPA to help him squeeze out of it whose fees will hopefully be less than the tax he wants to avoid).


The best way to find out whether or not you have an A/B trust is to call your attorney and ask.  The name used for the B trust vary from attorney to attorney (and there are several types — some are actually A/B/C trusts!) so there is no way for me to tell you what exact wording to look for in your trust.  I know that is a let down, but here at Ask Roxy we pass you the torch of information and empower you to run.

No comments:

Post a Comment

Related Posts Plugin for WordPress, Blogger...